As a small business owner, your main focus is running your business and handling the daily tasks that that entails. If you have not started thinking about retiring, you are not alone. It is estimated that up to 75% of small business owners do not have any retirement plans in place. While some Canadians have retirement programs set up by their employers, that is a benefit that small business owners do not enjoy. It is, therefore, up to the small business owner to plan their own retirement. We are going to look at how small business owners in Canada can do just that, as well as how to meet their financial needs in retirement.
When Would You Like to Retire?
Thinking about when you would like to retire is a great place to start because it will dictate how you plan for retirement. Also, having a fixed date lets you know how much longer you need to keep working and gives you a tangible date to work towards. Knowing how much longer you have left also dictates how much money you need to save to have a comfortable retirement.
In addition to your financial health and that of your loved ones, you also need to think about the lifestyle you would like after retirement. Your desired lifestyle will also determine how much you need to put aside. Things like travelling, volunteering or spending time with your family are some of the important lifestyle choices you will need to think about.
If you decide to retire but still provide input into your business, you also need to factor in whether you will work part-time or spend time providing advice to the person who takes over your business.
Funding Your Retirement
There are several options that can help you live comfortably after retirement. Opinions such as the Old Age Security and the Canadian Pension Plan can provide a decent amount to live on. Other options include Retirement Compensation Arrangements and Individual Pension Plans.
Small business owners who do not want to have anything to do with the business after they retire can sell the business and use the money to fund their retirement. This can be a little complicated because business owners need to think about possible buyers and getting a fair market value when they are ready to sell.
Apart from all the above options, you can also choose a Registered Retirement Savings Plan (RRSP) that offers a tax-advantaged saving option.
What Is a Registered Retirement Savings Plan (RRSP)?
An RRSP is a retirement savings option created by the Canadian government to give tax breaks to individuals who would like to invest in one. By deferring the payment of tax on the money saved in an RRSP until it is withdrawn, the Canadian government incentivises people to save for their money using these plans.
According to Wealthsimple’s RRSP guide, although you will need to pay tax when you withdraw money from your RRSP, you will likely be retired by then, and because your income will be smaller than it is now, the amount of tax you pay will also be lower. Wealthsimple helps you save and grow your money through their automated investment service. They also offer different financial tools for easier money management, low fees as well as real human support for when you need help with your RRSP or one of the other investment and financial services they offer.
Withdrawing from an RRSP
Once you have an RRSP and have been saving for some time, you will eventually need the money. You can choose to withdraw the money before or after retirement. Even though you can withdraw from your RRSP before this age, the government will regard that money as income and it will be taxed at a higher rate than if you withdrew after retirement. So, how do you withdraw from your RRSP before retirement?
The first option is the Home Buyer’s Plan (HBP). If you are a first-time homebuyer, you can use the HBP to withdraw the money you need to purchase a new home from your RRSP. The government classifies first-time home buyers as those who have not lived in a home that they, or their current spouse or partner own in four years. It is also possible to be classified as a first-time buyer again once a four-year period has elapsed.
If you decide to use an HBP, note that you will need to put back the money you withdrew in 15 years. Generally, you need to start making the payments a year after withdrawing the money.
The other option to withdraw from an RRSP is using a Lifelong Learning Plan (LLP). An LLP allows you to get an interest-free loan to finance education or training for you, a spouse or partner. The limit for withdrawals is $10,000 per year, with the total you can withdraw being $20,000.
If you go over any of these limits, the extra money is regarded as income for the years you are over the limit.
Converting an RRSP into an RRIF
The two options discussed above let you use money in your RRSP before retiring. If you do not need to do so, then you will spend the money in the RRSP after retiring. If you have retired or are close to retiring, you should know about the Registered Retirement Income Fund (RRIF).
An RRIF can be best explained as the opposite of an RRSP. RRSPs help you save for retirement as discussed above, while an RRIF helps you make annual withdrawals to furnish you with the money you need for a comfortable retirement.
RRIFs give you different options to invest your money. You can invest in lots of different options including Exchange Traded Funds, Guaranteed Interest Options, mutual funds, segregated funds and a lot more.
The flexibility RRIFs give you comes with some responsibilities. You need to make sure you withdraw only what you need because withdrawing too much money in the short-term leaves very little to live on down the line.
When is the RRSP Converted to an RRIF?
When you turn 71, you get the option to either withdraw the savings inside your RRSP as a lump sum or to convert the RRSP into an RRIF or other income product.
Do note that if you convert your RRSP into an RRIF, you need to start withdrawing an RRIF income by the last day of the year you turn 72. So, if you turn 71 in 2021, you need to start taking an income from your RRIF by December 31, 2022.
RRIFs and Taxation
An RRIF is taxable. When you pay into an RRSP, your income tax is lowered because you will end up in a lower tax bracket as your contributions are deducted from your income, leaving you with a smaller income that is then used to calculate your income tax.
However, those taxes do not go away completely and come up when you withdraw from your RRIF. You will not be required to pay any taxes when you convert your RRSP into an RRIF because you will not be withdrawing money at that point. However, all annual withdrawals are regarded as income and will be taxed as income for the year you withdraw the money.
The least amount you can withdraw from the RRIF is calculated as a percentage of the total investments you have at the beginning of the year. These percentages increase over the years. Also, RRIFs give you the flexibility to choose how often you would like to withdraw from your account. It could be monthly or every 3, 6 or 12 months.
The Canadian government has also set guidelines on how you can withdraw money from your RRIF. The minimum amount starts at 5% when you retire at 71 and goes up to 20% if you are 95 years and older. You are also allowed to use your partner’s age to calculate the minimum withdrawal amount if they are younger than you.
What Else You Need to Know
You can convert your RRIF back to an RRSP, but only if you have not reached the age of 71. Once the RRIF is created, you cannot put any money into it and you cannot cancel it. You are also allowed to have multiple RRIFs. The main benefit of doing this is that you can convert one of them into an RRIF, keep withdrawing money from it, while still contributing to other RRSPs until you turn 71. Once you get to 71, you can open another RRIF and move all the money from any RRSPs you have into it.
Thinking about retirement is hard for a lot of people because it indicates changes that need to be made. The biggest changes include lifestyle and financial changes. However, with proper planning, it is possible to still have a similar lifestyle to the one you had before retirement while having enough money to fund a comfortable retirement. Because there are many saving options that can prepare you for retirement, it is always a good idea to talk to a financial advisor so they can help you choose the best option for you.